EBI is happy to announce a contribution of Agnieszka Smoleńska and Jens van ‘t Klooster in the EBI Working Paper Series No. 104. Their paper entitled “A Risky Bet: Should the EU Choose a microprudential or a Credit Guidance Approach to Climate Risk?” was published on 25 October 2021.
Banking regulation and supervision have a key role to play in realising the EU’s climate change objectives. In this article Smoleńska and Van ‘t Klooster analyse the EU-level initiatives currently underway to green the banking system, in particular with regard to the microprudential rulebook for banks. The researchers document how regulators work hard to fit climate change concerns into the existing objectives of the microprudential framework. They also assess whether these efforts are likely to be successful by sketching two ways forward, which involve their own distinct hazards. The first is a predominantly microprudential approach which sees policy-makers force banks to develop adequate internal risk management procedures while taking a largely agnostic approach as to what methodologies are appropriate. If this is the way forward, the article suggests there are a number of risks: banks have a clear incentive to downplay risk, while large financial institutions gain a significant advantage and the distribution of responsibility between banks and supervisors becomes blurred. The article also explores a second “credit guidance” approach, in which regulators provide fine-grained guidance on how banks should evaluate climate risk. Although this approach is overall the more effective route to greening EU banking, Smoleńska and Van ‘t Klooster also see challenges of an entirely different sort: regulators will unavoidably face political choices and EU lawmakers need to consider issues of legality, legitimacy and accountability. In this regard, the researchers argue, the EU faces a risky bet.